The Impact of the Liquidity Coverage Ratio (LCR) on the Implementation of Monetary Policy

• Published in: Economic notes - Monte Paschi Siena Vol. 42; no. 2; pp. 135 - 170
• Main Author: SCHMITZ, STEFAN W.
• Format: Journal Article
• Language: English
• Published: Siena Blackwell Publishing Ltd 01.07.2013
• Subjects: Economic statistics; Eurozone; Liquidity; Monetary policy; Monetary theory; Money markets; Regulation of financial institutions; Studies
• ISSN: 0391-5026; 1468-0300
• DOI: 10.1111/j.1468-0300.2013.12006.x

This paper analyses the impact of the short‐term component of the new Basel III liquidity standards, namely the liquidity coverage ratio (LCR), on the implementation of monetary policy in the euro area. It employs a conceptual framework to investigate the interaction between the money market and monetary policy implementation. Based thereon, it argues that the isolated focus on the impact on the LCR tends to underestimate the future challenges to monetary policy implementation for two reasons: first, feedback and network dynamics exacerbate the impact of the standard; second, the ongoing crisis itself challenges monetary policy implementation in the euro area by its impact on the (perceived) arbitrage relationship between open market operations and the unsecured money market. The paper concludes by discussing potential policy reactions concerning both, the calibration of the LCR and the framework for monetary policy implementation.